2. Suppose call and put prices are given by: Strike Call Premium Put Premium 80 22 4 100 9 21 105 5 24.80 Find the convexity violations by computing the change in premium per dollar change in the strike price. What spread would you use to effect arbitrage? (Hint: 1:5:4) Demonstrate that the spread position is an arbitrage.

2. Suppose call and put prices are given by: Strike Call Premium Put Premium 80 22 4 100 9 21 105 5 24.80 Find the convexity violations by computing the change in premium per dollar change in the strike price. What spread would you use to effect arbitrage? (Hint: 1:5:4) Demonstrate that the spread position is an arbitrage.

Essentials Of Investments

11th Edition

ISBN:9781260013924

Author:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.

Publisher:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.

Chapter1: Investments: Background And Issues

Section: Chapter Questions

Problem 1PS

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Suppose that the lending rate re and the borrowing rate r, under continuous compounding are different for investors so that re < rp. Show that the no-arbitrage forward price F(0,T) satisfies Soe"T < F(0,T) < Soe™%T.
4. (DOUBLE CREDIT a. Where the left and right tic-marks are exercise prices 60 and 80, respectively, explain how the "strangle" payoff above can be created with a put and call. b. Suppose that the price variance of the underlying security rises. What happens to the payoff pattern from the point of view of a prospective purchaser of the put and call. Explain.
True or false explain a. For , when the spot price is the strike price, then the profit/loss will be equal to the spot price minus the minus the premium. b. For , when the spot price is the strike price, then the profit/loss will be equal to the strike price minus spot the price minus the .
5. (Replicating strategy for pricing) To price a derivative, we can use risk-neutral pricing. As an alternative yet equivalent method, we can construct price the derivative using replicating strategies. Consider a 1-period binomial model, where we have three nodes No.0, N1.0, N1.1. We have a cash account with fixed interest rate r = 0.01 - that is, if we have at No.0 cash account with D dollars, we expect (1+ r)D at either N1.0 or N1.1. We also have a stock with price S0.0 10 at No,0, S1,0 = 8 at N1,0 and S1,1 = 15 at N1,1. Now consider an European call option at time t = 1 with strike K = 12. Can you price the option at No.0 using a replicating strategy, and what is the price? Please submit your answer rounded to only one decimal digit - for example if your answer is 1.28, then submit 1.3. If your answer is 1.12, submit 1.1.
. Answer the following in a couple of sentences d) Compare swaps with forwards f) Why do you buy on margin?
Q (a) A put and a call have the same maturity and strike price. If they have the same price, which one is in the money? Prove your answer and provide an intuitive explanation. (b) You find a put and a call with the same exercise price and maturity. What do you know about the relative prices of the put and call? Prove your answer and provide an intuitive explanation. Please explain step by step. I have seen other answers but still very confused.
Answer the following in a couple of sentences. e) Compare swaps with forwards f) Why do you buy on margin?
Put–Call Parity - A put and a call have the same maturity and strike price. If they have the same price, which one is in the money? Prove your answer and provide an intuitive explanation.
If I have that the standard estimator of the volatility parameter is 0.2491, how can I estimate the drift parameter, mu, for some price paths assuming the price paths can be modeled by a risk-neutral geometric Brownian motion and the interest rate is 0? (I need to consider how the drift parameter is related to the volatility in a risk-neutral setting.)
A forward contract has an underlying asset which, in Cox-RossRubenstein notation, has S=22,u=1.2 and d=0.9. This forward contract matures in one time step and the return over this time step is R=1.02. Assuming the forward price is calculated rationally, what is the value of the forward at node (1,1)? (Give your answer as a positive number.)
Q2 (Exercise 9.9) Suppose call and put prices are given by Strike 50 55 Call premium 16 10 Put premium 7 14 What no-arbitrage property is violated? What spread position would you use to effect arbitrage? Demonstrate that the spread position is an arbitrage.
Suppose the demand functions for two products are q1 = f(p1, p2) and q2 = g(p1, p2) wherep1, p2, q1, and q2 are the prices (in dollars) and quantities for products 1 and 2. Consider thefour partial derivatives∂q1/∂p1,∂q1/∂p2,∂q2/∂p1and ∂q2/∂p2,State the sign of each of these partial derivatives if:(a) the products are complementary goods(b) the products are substitute goods.

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